In New York City’s Opportunity Zones, Investors See Potential Risks And Rewards
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Last May, the Empire State Development Corp. nominated 514 census tracts as eligible investment opportunities for the federal Opportunity Zones program, which provides developers and investors a tax break if they invest in underserved or underdeveloped communities. Of the census tracts submitted by the state of New York, 300 are located in the New York City metro area.
Investors are eager to reap the rewards of this new program, but many commercial real estate professionals are cautiously optimistic as they educate themselves about it.
In October, the Internal Revenue Service released additional proposed regulations and guidance for investors hoping to invest in a Qualified Opportunity Fund. The guidance provided more clarity about investing in an opportunity fund, but questions still linger.
One source of confusion among investors and developers is how certain words and phrases used in the IRS’ documentation should be defined. For example, clear guidance is still needed to define the “substantially all” verbiage as it relates to the definition of qualified opportunity zone business property.
“It is unlikely we will get answers to every question,” Mazars Senior Manager Bonni Zukof said. “It is up to investors, along with their advisers, to keep in mind the original intent of the incentive program when determining the risks of making an investment into a QOF.”
Despite this uncertainty, many investors are bullish about the program and its long-term benefits.
“The benefit of investing in a QOF is the deferral and potential elimination of income tax,” Mazars manager John Confrey said. “The amount of gain realized from the sale or exchange of an asset can be rolled over into a QOF. At the time of investment into the QOF, the taxpayer does not pay any capital gain tax. The fund then buys an asset in a Qualified Opportunity Zone."
Investments transferred through QOFs into Qualified Opportunity Zones reward long-term investments over short-term ones. The longer investors and developers hold an asset in these designated areas, the higher the exemption from capital gains taxes will be. Investors who hold a property for at least five years receive a 10% reduction on the initial capital gain, and that number jumps an additional 5% to 15% after seven years. On Dec. 31, 2026, tax is due on 85% of the original capital gain, assuming the investment is held for a minimum of seven years.
After 10 years, the real benefits kick in. If investors hold an investment in a QOF for a minimum of 10 years, they permanently exclude post-acquisition appreciation in the QOF investment from taxable income when the QOF investment is sold, Mazars Senior Manager Adam Liebman said.
The proposed regulations provide further insight into how long investors can wait before they decide to put money into a fund. Professionals have expressed concern that tax incentives would expire in 2028, in which case investors would need to invest now in order to fully cash out at the end of the program. The proposed regulations clarified that investments that meet the 10-year holding period requirement after Dec. 31, 2026, are eligible for the exclusion as long as they are sold no later than Dec. 31, 2047.
Many investors and developers are using this extra time to learn more about the program and strategically place their investments. Others are diving in right away.
SkyBridge Capital, the hedge fund started in 2005 by former White House Director of Communications Anthony Scaramucci, announced plans to raise up to $3B for investments in QOFs. Skybridge sees the program as a window of opportunity.
“This will be a game-changing product for SkyBridge,” Scaramucci said to Business Insider. “This will likely be bigger and more important to the firm than our current fund of funds.”
SkyBridge Capital’s announcement came just weeks after the new guidance, which also identifies exactly what a QOF is and who can start one.
Investors do not need to be multimillionaires or backed by a big bank. According to the IRS, any interested investor can start a fund by completing Form 8996 and attaching it to their federal income tax return.
"A fund could just be a two-person partnership," Kosmont Cos.' founder Larry Kosmont said to Bisnow. "It could be a real estate developer and a city or an investor who gets together and pool capital gains they have and decide they are going to these zones and purchase a property and renovate the building."
While industry professionals are more optimistic than they were before the guidelines came out, many are reluctant to invest in funds just yet. Several developers and investors have said they need more information than the new guidance provides.
"Qualified Opportunity Funds provide investors with several incentives: deferring tax, reducing tax and excluding tax," Confrey said. "Investors who find and invest in those QOFs that are primed for resurgence will be the ones who truly maximize the benefit of this program."
The Treasury Department said it will issue another iteration of the regulations before 2019.
For more information on the impact of opportunity zones, check out the Mazars USA Tax Alert on Opportunity Zones.
This feature was produced in collaboration between Bisnow Branded Content and Mazars. Bisnow news staff was not involved in the production of this content.